Electronic trading
Encyclopedia
Electronic trading, sometimes called etrading, is a method of trading securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...

 (such as stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

s, and bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

s), foreign exchange
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...

 or financial derivatives
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...

 electronically. Information technology
Information technology
Information technology is the acquisition, processing, storage and dissemination of vocal, pictorial, textual and numerical information by a microelectronics-based combination of computing and telecommunications...

 is used to bring together buyers and sellers through electronic trading platform
Electronic trading platform
In finance, an Electronic trading platform is a computer system that can be used to place orders for financial products over a network with a financial intermediary. This includes products such as shares, bonds, currencies, commodities and derivatives with a financial intermediary, such as a...

 and networks to create a virtual market places such as NASDAQ
NASDAQ
The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...

, NYSE Arca
NYSE Arca
NYSE Arca, previously known as ArcaEx, an abbreviation of Archipelago Exchange, is a securities exchange on which both stocks and options are traded...

 and Globex which are also known as electronic communications networks or ECNs.

Electronic trading is in contrast to older floor trading
Floor trading
Floor trading is where traders or stock brokers meet at a specific venue referred to as a trading floor or pit to buy and sell financial instruments using open outcry method to communicate which each other. These venues are typically stock exchanges or futures exchanges and transactions are...

 and phone trading and has a number of advantages, but glitches and cancelled trades do still occur.

Background

Historically, stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...

s were physical locations where buyers and sellers met and negotiated. With the improvement in communications
Telecommunication
Telecommunication is the transmission of information over significant distances to communicate. In earlier times, telecommunications involved the use of visual signals, such as beacons, smoke signals, semaphore telegraphs, signal flags, and optical heliographs, or audio messages via coded...

 technology in the late 20th century, the need for a physical location became less important, as traders could transact from remote locations.

One of the earliest examples of widespread electronic trading was on Globex, the CME Group
CME Group
The CME Group bases prices for US gasoline on Brent Crude rather than West Texas Intermediate Crude , which many believe is responsible for artificially high gas prices for US consumers...

’s electronic trading platform
Electronic trading platform
In finance, an Electronic trading platform is a computer system that can be used to place orders for financial products over a network with a financial intermediary. This includes products such as shares, bonds, currencies, commodities and derivatives with a financial intermediary, such as a...

 that allows access to a variety of financial, foreign exchange and commodity markets. The Chicago Board Of Trade produced a rival system that was based on Oak Trading Systems’ Oak platform which facilitated ‘E Open Outcry,’ an electronic trading platform that allowed for electronic trading to take place alongside the trading that took place in the CBOT pits. Oak Trading Systems continues to offer access to global markets via various software applications, including demo packages, and products are available through reputable brokerage firms such as EHedger LLC http://www.ehedger.com.

Electronic trading makes transactions easier to complete, monitor, clear, and settle. NASDAQ
NASDAQ
The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...

, set up in 1971, was the world's first electronic stock market, though it originally operated as an electronic bulletin board, rather than offering straight-through processing (STP). By early 2007, organizations like the Chicago Mercantile Exchange
Chicago Mercantile Exchange
The Chicago Mercantile Exchange is an American financial and commodity derivative exchange based in Chicago. The CME was founded in 1898 as the Chicago Butter and Egg Board. Originally, the exchange was a non-profit organization...

 were creating electronic trading platforms to support the emerging interest in trading within the foreign exchange market
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...

.

Today many investment firms on both the buy side
Buy side
Buy-side is a term used in investment banking to refer to advising institutions concerned with buying, rather than selling, assets or securities...

 and sell side
Sell side
Sell side is a term used in the financial services industry. It is a general term that indicates a firm that sells investment services to asset management firms, typically referred to as the buy side, or corporate entities...

 are increasing their spending on technology for electronic trading. Many floor traders and brokers are being removed from the trading process. Traders are relying on algorithms
Algorithmic trading
In electronic financial markets, algorithmic trading or automated trading, also known as algo trading, black-box trading or robo trading, is the use of electronic platforms for entering trading orders with an algorithm deciding on aspects of the order such as the timing, price, or quantity of the...

 to analyze market conditions and then execute their orders.

Dates of introduction of electronic trading by the leading exchanges in 120 countries are provided in a Journal of Finance article published in 2005 “Financial market design and the equity premium: Electronic vs. floor trading,”.

There are, broadly, two types of trading in the financial markets:
  • Business-to-business
    Business-to-business
    Business-to-business describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer...

     (B2B) trading, often conducted on exchanges, where large investment banks and broker
    Securities lending
    In finance, securities lending or stock lending refers to the lending of securities by one party to another. The terms of the loan will be governed by a "Securities Lending Agreement", which requires that the borrower provides the lender with collateral, in the form of cash, government securities,...

    s trade directly with one another, transacting large amounts of securities, and
  • Business-to-consumer (B2C) trading, where retail (e.g. individuals buying and selling relatively small amounts of stocks and shares) and institutional clients (e.g. hedge funds, fund managers or insurance companies, trading far larger amounts of securities) buy and sell from brokers or "dealers", who act as middle-men between the clients and the B2B markets.


While the majority of retail trading probably now happens over the Internet, retail trading volumes are dwarfed by institutional, inter-dealer and exchange trading.

Before the advent of eTrading, exchange trading would typically happen on the floor of an exchange, where traders in brightly colored jackets (to identify which firm they worked for) would shout and gesticulate at one another - a process known as open outcry
Open outcry
Open outcry is the name of a method of communication between professionals on a stock exchange or futures exchange. It involves shouting and the use of hand signals to transfer information primarily about buy and sell orders...

 or "pit trading" (the exchange floors were often pit-shaped - circular, sloping downwards to the centre, so that the traders could see one another).

For instruments which aren't exchange-traded (e.g. U.S. treasury bonds), the inter-dealer market substitutes for the exchange. This is where dealers trade directly with one another or through inter-dealer brokers (i.e. companies like GFI Group, BGC Partners and Garban, who act as middle-men between dealers such as investment banks). This type of trading traditionally took place over the phone but brokers are beginning to offer eTrading services.

Similarly, B2C trading traditionally happened over the phone and, while much of it still does, more brokers are allowing their clients to place orders using electronic systems. Many retail (or "discount") brokers (e.g. Charles Schwab
Charles Schwab
Charles Schwab may refer to:*Charles M. Schwab , American steel magnate*Charles R. Schwab , founder of the eponymous brokerage*Charles Schwab Corp., an American based brokerage firm...

, E-Trade) went online during the late 1990s and most retail stock-broking probably takes place over the web now.

Larger institutional clients, however, will generally place electronic orders via proprietary electronic trading platform
Electronic trading platform
In finance, an Electronic trading platform is a computer system that can be used to place orders for financial products over a network with a financial intermediary. This includes products such as shares, bonds, currencies, commodities and derivatives with a financial intermediary, such as a...

s such as Bloomberg Terminal
Bloomberg Terminal
The Bloomberg Terminal is a computer system provided by Bloomberg L.P. that enables financial professionals to access the Bloomberg Professional service through which users can monitor and analyze real-time financial market data movements and place trades on the electronic trading platform...

, Reuters 3000 Xtra
Reuters 3000 Xtra
Reuters 3000 Xtra is an electronic trading platform typically used by professional traders and investment analysts in trading rooms. It provides real time streaming price date on exchange traded stocks, warrants, options, futures, indices, bonds, commodities and foreign currencies as well...

, BondsPro, Thomson TradeWeb
Thomson Financial
Thomson Financial was an arm of The Thomson Corporation, which was one of the world's leading information companies, focused on providing integrated information solutions to business and professional customers...

 or CanDeal
CanDeal
CanDeal is a global online marketplace for Canadian dollar debt securities. It provides online access to liquidity for Canadian Government Bonds and money market instruments. CanDeal’s technology is available to institutional investors in Canada, the United States and Europe. CanDeal services...

 (which connect institutional clients to several dealers), or using their brokers' proprietary software.

Impact

The increase of eTrading has had some important implications:
  • Reduced cost of transactions - By automating as much of the process as possible (often referred to as "straight-through processing" or STP), costs are brought down. The goal is to reduce the incremental cost of trades as close to zero as possible, so that increased trading volumes don't lead to significantly increased costs. This has translated to lower costs for investors.
  • Greater liquidity - electronic systems make it easier to allow different companies to trade with one another, no matter where they are located. This leads to greater liquidity (i.e. there are more buyers and sellers) which increases the efficiency of the markets.
  • Greater competition - While etrading hasn't necessarily lowered the cost of entry to the financial services industry, it has removed barriers within the industry and had a globalisation-style competition effect. For example, a trader can trade futures on Eurex
    Eurex
    Eurex is one of the world's leading derivatives exchanges, providing European benchmark derivatives featuring open and low-cost electronic access globally...

    , Globex or LIFFE at the click of a button - he or she doesn't need to go through a broker or pass orders to a trader on the exchange floor.
  • Increased transparency - Etrading has meant that the markets are less opaque. It's easier to find out the price of securities when that information is flowing around the world electronically.
  • Tighter spreads - The "spread" on an instrument is the difference between the best buying and selling prices being quoted; it represents the profit being made by the market maker
    Market maker
    A market maker is a company, or an individual, that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid-offer spread, or turn. From a market microstructure theory standpoint, market makers are net sellers of an option to be...

    s. The increased liquidity, competition and transparency means that spreads have tightened, especially for commoditised, exchange-traded instruments.


For retail investors, financial services on the web offer great benefits. The primary benefit is the reduced cost of transactions for all concerned as well as the ease and the convenience. Web
World Wide Web
The World Wide Web is a system of interlinked hypertext documents accessed via the Internet...

-driven financial transactions bypass traditional hurdles such as logistics
Logistics
Logistics is the management of the flow of goods between the point of origin and the point of destination in order to meet the requirements of customers or corporations. Logistics involves the integration of information, transportation, inventory, warehousing, material handling, and packaging, and...

.

Technology and systems


Etrading systems are typically proprietary software (etrading platforms or electronic trading platform
Electronic trading platform
In finance, an Electronic trading platform is a computer system that can be used to place orders for financial products over a network with a financial intermediary. This includes products such as shares, bonds, currencies, commodities and derivatives with a financial intermediary, such as a...

s), running on COTS
Commercial off-the-shelf
In the United States, Commercially available Off-The-Shelf is a Federal Acquisition Regulation term defining a nondevelopmental item of supply that is both commercial and sold in substantial quantities in the commercial marketplace, and that can be procured or utilized under government contract...

 hardware and operating systems, often using common underlying protocols, such as TCP/IP.

Exchanges typically develop their own systems (sometimes referred to as matching engines), although sometimes an exchange will use another exchange's technology (e.g. e-cbot, the Chicago Board of Trade
Chicago Board of Trade
The Chicago Board of Trade , established in 1848, is the world's oldest futures and options exchange. More than 50 different options and futures contracts are traded by over 3,600 CBOT members through open outcry and eTrading. Volumes at the exchange in 2003 were a record breaking 454 million...

's electronic trading platform, uses LIFFE's Connect system), and some newer electronic exchanges use 3rd-party specialist software providers (e.g. the Budapest stock exchange
Budapest Stock Exchange
The Budapest Stock Exchange was re-opened in 1990 with headquarters in Budapest, Hungary.BSE is the key institution of the Hungarian Financial market and the official trading venue for publicly offered securities....

 and the Moscow Interbank Currency Exchange
Moscow Interbank Currency Exchange
The Moscow Interbank Currency Exchange or MICEX is one of the largest universal stock exchanges in the Russian Federation and East Europe. MICEX opened in 1992 and is the leading Russian stock exchange...

) use automated trading software originally written and implemented by FMSC, an Australian technology company that was acquired by Computershare, and whose intellectual property rights are now owned by OMX
OMX
OMX AB is a Swedish-Finnish financial services company, formed in 2003 through a merger between OM AB and HEX plc and is now a part of the NASDAQ OMX Group since February 2008.It has two divisions, OMX Exchanges, which operates eight stock exchanges mainly in the Nordic and Baltic...

.

Exchanges
Exchange (organized market)
An exchange is a highly organized market where tradable securities, commodities, foreign exchange, futures, and options contracts are sold and bought.-Description:...

 and ECN
ECN
ECN may refer to:* Eastern Counties Newspapers, a company now known as Archant* Eastman Color Negative, a photographic processing system for motion-picture films* Electrochemical noise, fluctuations of current and potential...

s generally offer two methods of accessing their systems -
  • an exchange-provided GUI
    Graphical user interface
    In computing, a graphical user interface is a type of user interface that allows users to interact with electronic devices with images rather than text commands. GUIs can be used in computers, hand-held devices such as MP3 players, portable media players or gaming devices, household appliances and...

    , which the trader runs on his or her desktop and connects directly to the exchange/ECN, and
  • an API
    Application programming interface
    An application programming interface is a source code based specification intended to be used as an interface by software components to communicate with each other...

     which allows dealers to plug their own in-house systems directly into the exchange/ECN's.


From an infrastructure point of view, most exchanges will provide "gateways" which sit on a companies' network, acting in a manner similar to a proxy
Proxy server
In computer networks, a proxy server is a server that acts as an intermediary for requests from clients seeking resources from other servers. A client connects to the proxy server, requesting some service, such as a file, connection, web page, or other resource available from a different server...

, connecting back to the exchange's central system.

ECNs will generally forego the gateway/proxy, and their GUI or the API will connect directly to a central system, across a leased line.

Many brokers develop their own systems, although there are some third-party solutions providers specializing in this area. Like ECNs, brokers will often offer both a GUI and an API (although it's likely that a slightly smaller proportion of brokers offer an API, as compared with ECNs), and connectivity is typically direct to the broker's systems, rather than through a gateway.

Investment banks and other dealers have far more complex technology requirements, as they have to interface with multiple exchanges, brokers and multi-dealer platforms, as well as their own pricing, P&L, trade processing and position-keeping systems. Some banks will develop their own etrading systems in-house, but this can be costly, especially when they need to connect to many exchanges, ECNs and brokers. There are a number of companies offering solutions in this area.

Algorithmic trading

Some electronic trades are not planned or executed by human traders, but by complex algorithms.

See also

  • eCommerce
  • Electronic Communication Network
    Electronic Communication Network
    An electronic communication network is the term used in financial circles for a type of computer system that facilitates trading of financial products outside of stock exchanges. The primary products that are traded on ECNs are stocks and currencies. The first ECN, Instinet, was created in 1969...

     (ECN)
  • Electronic trading platform
    Electronic trading platform
    In finance, an Electronic trading platform is a computer system that can be used to place orders for financial products over a network with a financial intermediary. This includes products such as shares, bonds, currencies, commodities and derivatives with a financial intermediary, such as a...

  • Stock market data systems
    Stock market data systems
    Stock market data systems communicated market data—information about securities and stock trades—from stock exchanges to stock brokers and stock traders.-History:...

  • Straight Through Processing
    Straight Through Processing
    Straight-through processing enables the entire trade process for capital markets and payment transactions to be conducted electronically without the need for re-keying or manual intervention, subject to legal and regulatory restrictions...

     (STP)
  • Trading room
    Trading room
    A trading-room gathers traders operating on financial markets.The trading-room is also often called the front office.The terms dealing-room and trading-floor are also used, the latter being inspired from that of a open outcry stock exchange....

  • Electronic Trading Event
The source of this article is wikipedia, the free encyclopedia.  The text of this article is licensed under the GFDL.
 
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